Stock prices may appear random, but there are repeating price cycles, which are predominantly driven by the participation of large financial institutions. The activity of large institutional buying plays out in four distinct phases:

  1. Accumulation
  2. Markup
  3. Distribution
  4. Markdown

A trader must have a strategy to take advantage of price action as it is happening. Understanding the four phases of price will maximize returns because only one of the phases gives the investor optimum profit opportunity in the stock market. When you become aware of stock cycles and the phases of price, you will be prepared to profit consistently with less drawdown.

Accumulation Phase
The accumulation phase begins when institutional investors (such as mutual funds, pension funds and large banks) buy up substantial shares of a given stock. Price forms a base as the shares of stock are accumulated. Institutional investors must buy over long periods of time so as not to conspicuously drive up the price of the stock; they therefore have a long time horizon.

This phase is not a lucrative time for retail investors to buy, as capital will be tied up, or the investor may experience a large drawdown of capital. However, recognizing the signs of accumulation gives insight to future opportunity. During this phase, price moves mostly sideways in a range. The range is identified by variable pivot highs and lows (Figure 1) and whipsaw-type price movement.

Figure 1: Variable pivot highs and lows and price is sideways. Notice the length of the cycle (green highlight)
Source: TDAmeritrade Strategy Desk

The cup and handle is another price pattern indicating accumulation. The handle is a higher pivot low and may signal the end of an accumulation cycle. A higher high in price above the rim of the "cup" can lead to a new leg up.

Figure 2: Cup-and-handle pattern during the accumulation phase
Source: TDAmeritrade Strategy Desk

The accumulation phase can wear down your capital as price will swing in both directions. Sometimes it is useful to add an indicator to help identify non-trending conditions. The average directional index (ADX) is a trend-strength indicator, and the example in Figure 3 shows price moving sideways. The ADX has been added to show trend strength. An ADX of less than 25 shows low trend strength, indicating non-trending conditions. The ADX rises above the 25 level when there is trend strength. (For further reading about the ADX, see ADX: The Trend Strength Indicator. For background information, see our Exploring Oscillators And Indicators tutorial.)

Figure 3: Accumulation phase - low ADX shows non-trending conditions
Source: TDAmeritrade Strategy Desk

Markup Phase
During the markup phase, price breaks out of range and begins a sustained uptrend. An uptrend is defined as a series of higher pivot highs and higher pivot lows.This stage is when price begins moving up. The big money has established a position and retail investors are now invited to join in the profit party. This is the most profitable time to own the stock - an opportunity to let your profits run. The earlier you can recognize this stage, the more you can profit.
Use trend-trading strategies during this stage. An example of a trend-trading strategy would be to draw a trendline along the pivot lows and stay long above the upward trendline. Entering a stock early in the markup phase leads to the greatest potential profits. Classic trend trading involves entering the stock at pullbacks above the trendline (Figure 4). (Learn how to use trendlines effectively in Track Stock Prices With Trendlines.)

Figure 4: Markup phase. Trends are more likely to continue than reverse, so continue to ride the trend as long as price remains above the trendline.
Source: TDAmeritrade Strategy Desk

The ADX helps us see the transition from the accumulation phase to the markup phase. When the ADX rises above 25 at the same time as a new high in price, the trend may be starting. The best trends will have agreement between the indicator and price, as noted in Figures 5 and 6. The trend is truly your friend; let your profits run. (Check out our Technical Analysis tutorial for more information.)

Figure 5: From accumulation phase to markup phase
Source: TDAmeritrade Strategy Desk
Figure 6: Markup phase, a time of trend
Source: TDAmeritrade Strategy Desk

Uptrends occur in this cycle and price makes higher highs. When trend momentum is increasing, as seen in higher ADX peaks, we can expect the trend to continue. Figure 6 also shows a triangle pattern in the accumulation phase and then a new price high, showing us how the markup phase begins and a trend is born.

The price may continue the trend or enter a reversal; more often than not, the trend will continue after a test of support/resistance.

Rectangle patterns represent price consolidation and can happen when stock shares are being accumulated or distributed. Recognizing the sideways trend leads to the best strategy for profit. An investor can be out of the trade for this period or, if there is a dividend and/or options, another strategy might be to hold and collect dividends and sell covered calls. It is easier to identify in hindsight, but learning to recognize consolidation when it is happening provides an edge in profit trading. (For more, see our Analyzing Chart Patterns tutorial.)

Figure 7: Rectangle pattern, price is sideways
Source: TDAmeritrade Strategy Desk

In Figure 7, you can see rectangle price patterns in the markup phase for the Energy Select Sector SPDR (AMEX:XLE), which leads to continuation of the trend as seen in Figure 8. A new high in price from a rectangle pattern is a technical buy signal. A new low in price is a technical sell signal.

Figure 8: Continuation of trend in markup phase
Source: TDAmeritrade Strategy Desk

Distribution Phase
The distribution phase begins as the markup phase ends and price enters another range period. The shares are being sold over a period of time - the opposite of accumulation. This time, the sellers want to maintain higher prices until he or she has sold the shares.
Whether it is distribution or accumulation is less easy to discern at this point. It is more important to be prepared for the next signal, rather than trying to predict the next move.

One of the most common distribution patterns is known as the head-and-shoulders pattern (Figure 9). Rounding or a dome shape (Figure 10) indicates distribution preceding the markdown stage.

Figure 9: A three-pivot reversal, distribution of shares
Source: TDAmeritrade Strategy Desk
Figure 10: Markdown follows distribution
Source: TDAmeritrade Strategy Desk

Markdown Phase
The last phase of the stock cycle is the markdown phase. Markdown begins when price makes a lower high and no new high (Figure 9). Markdown follows distribution, which is when institutions sell inventory, either for redemption reasons, simply taking profit or to change position into another stock or sector. The markdown phase is a downtrend (Figure 11).
Be careful that emotions do not rule trading during the markdown phase. Price is always the signal to watch; a series of lower pivot highs and lower pivot lows will signal a pullback in price or a trend reversal. A reversal is when price direction changes completely from the direction it was headed. Successful investors ensure that gains are banked, and money-management rules will not allow for holding a declining issue. (Learn to recognize a reversal when it happens in Retracement Or Reversal: Know The Difference.)

Figure 11: Markdown phase is represented by lower pivot highs and lower pivot lows. This is a reversal to a downtrend.
Source: TDAmeritrade Strategy Desk
Figure 12: The stock cycle
Source: TDAmeritrade Strategy Desk

Taking Stock
The study of stock cycles will give investors the heads-up on trending conditions for a stock, whether sideways, up or down. This allows the investor to plan a strategy for profit that takes advantage of what the price is doing. The entire cycle can repeat, or not. It is not necessary to predict it - it is necessary to have the right strategy.
Now you can apply this information to learn to manage risk. Once you have a gain, have a plan to keep some: a gain is not a profit until you bank it. You can use a stop-loss as part of your trade-management plan to help you capitalize on your gains.

Smart investors who recognize the different price cycles are able to take the best profit opportunities. The good news is that you can learn to make the right trade at the right time.

For related reading, check out Earnings Cyclicality Exposes Profitable Trends and The Ups And Downs Of Investing in Cyclical Stocks.

Related Articles
  1. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  2. Investing

    Procter & Gamble Restructures, Sheds 100 Brands

    All businesses face adversity, and Procter & Gamble is no exception. We take a look at recent developments affecting this global giant.
  3. Chart Advisor

    4 European Stocks to Consider Buying

    European companies, listed on US exchanges, that are providing buying opportunities right now.
  4. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  5. Chart Advisor

    ChartAdvisor for October 2 2015

    Weekly technical summary of the major U.S. indexes.
  6. Investing

    How Diversifying Can Help You Manage Market Mayhem

    The recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
  7. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  8. Technical Indicators

    Why MACD Divergence Is an Unreliable Signal

    MACD divergence is a popular method for predicting reversals, but unfortunately it isn't very accurate. Learn the weaknesses of indicator divergence.
  9. Investing

    5 Recession Resistant Industries

    No companies are completely recession proof, but some industries perform better in a weak economy than others.
  10. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  1. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  2. What are some of the most common technical indicators that back up Doji patterns?

    The doji candlestick is important enough that Steve Nison devotes an entire chapter to it in his definitive work on candlestick ... Read Full Answer >>
  3. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  4. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  5. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  6. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!